Wow, it’s ugly out there. But stocks are cheap. What should you do?
I’ll explain what I think you should do today.
Let’s look at both sides of the issue…
Pick your poison: The U.S. economic situation is worsening once again. Housing isn’t turning around and neither is employment. Inflation is up. Outside the U.S., Greece is at risk of default… So now, Europe’s banks are in crisis again. The list goes on.
In the wake of this, stocks have fallen 8% from their highs two months ago.
You could pick any combination of those reasons above as a reason for a new downtrend. But on the flip side, stocks are cheap…
By my simple math, the U.S. stock market is as cheap as it’s been in 20 years, based on the most widely accepted measures of stock market value – the price-to-earnings (P/E) ratio and price-to-book (P/B) ratio. Take a look:
This P/E ratio is a “recession-adjusted” P/E ratio. Late in the recessions ending in 1991, 2001, and 2009, the “E” (earnings) fell so far, the P/E ratio soared. In each case, the distortion lasted about two years. This chart adjusts for that. But we’ve officially been out of recession long enough, we’re not adjusting today’s number.
Judging by this chart, the last time stocks were this cheap was in 1991 – and the 1990s was one of the greatest decades in history to be an investor in stocks.
Today, we really do have favorable conditions for investing:
- Major stocks are trading at record-low valuations, while we have near-zero interest rates.
- Home prices more affordable than ever, with record-low mortgage rates.
- Gold investments are record-cheap, during a bull market in gold.
So we have terrible economic times… and great value in investments. What do we do?
I separate what matters from the “noise” by looking at the investment world through our True Wealth prism. My ideal investment meets three criteria: 1) it’s cheap, 2) it’s hated, and 3) it’s in an uptrend.
Well, stocks are cheap, as I showed above. And as I explained last week in DailyWealth, individual investors are scared – stocks are hated.
But over the last two months, the trend’s been trying to turn down. And it’s now getting worrisome…
You might be surprised to hear me say this… But out of the three things in our “prism,” the simple existing trend is the most important – the most consistently profitable. You don’t want to fight the trend.
I’m not foolish enough to fight the trend. It took me a long while in my career to learn not to fight the trend. (Honestly, I still struggle with it.) But I know it’s the right thing to do.
When everything is in a downtrend, there’s no point in trying to swim upstream.
With stocks as cheap as they are now, we can afford to miss the first 5%-10% of a new uptrend when it arrives.
It’s much safer to miss the first 5%-10% of the move, and get in once an uptrend appears, than it is to stand in front of an oncoming bus and predict it’s going to stop and turn around. Better to wait for it to make its turn and then hop on board.
I may be wrong, of course. So we’re watching our trailing stops closely. The trailing stops are our worst-case exit plan, so we don’t lose too much money if things go dramatically against us. I urge you to have an exit plan too.
For new money… yes, stocks are cheap and hated. But we don’t have an uptrend. I don’t want to commit new money to stocks until the uptrend reasserts itself.
The uptrend has proven to be the most important part of the prism. And it’s not clearly up now. Stocks might be cheap and hated… But there’s no urgency to buy right this second.
I’ll tell you when I think the dust has settled and the uptrend is back…
– Steve Sjuggerud
Source: Daily Wealth